Same Old Same Old: Active Managers Once Again Losing to the Index

Active managers are once again underperforming indexes, but that shouldn’t surprise you at all.  Every year Standard and Poor’s comes out with their scorecard--the Standard and Poor’s Indices versus Active Funds Scorecard (called SPIVA)--to look at the performance of actively managed mutual funds compared to their benchmark indexes.

As expected through mid 2010, active managers as a whole underperformed their respective indexes.

For example in the US if you divide the US stock market into large companies, mid size companies, and small companies, in almost every category active managers underperformed a simple index that just owns all the stocks in that asset class.  The same holds up for most international categories and bond categories as well.

You can read the whole report here if you want:

SPIVA Mid 2010

But you probably won’t find it very engaging reading.

Now none of this is really a surprise.

We expect that at any given moment in time--not just one year or one month, but at any instant--active managers on average should underperform a simple index.

The reason?

Remember if you divide the market into 2 types of investors--active and passive--and you know that the passive investor (one who simply owns the entire asset class by owning an index) must have a rate of return equal to the index by definition.  So therefore it must be true that the average active investor gets the same return.

But that’s BEFORE fees.

We know that the transaction costs for active management, which involves stock picking and market timing, are much higher than that of index funds and so AFTER fees the underperformance of active management simply becomes a matter of the difference in expenses.

Bottom line for you as an investor: skip active management and stick with index funds.